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Chapter One
Introduction
1.1. Background to the study
For development and growth in any society, the provision of basic infrastructure is quite
necessary. This perhaps explains why the government shows great concern for a medium through
which fund can be made available to achieve their set goals for the society. Government needs
money (funds) to be able to execute its social responsibility to the public. Meeting the needs
of the society no doubt calls for huge funds which an individual or society cannot contribute
alone, hence it becomes the responsibility of government to source for funds enable to provide
these basic amenities to the citizenry who are the beneficiaries. One of the medium through
which funds is derived is through taxation. The advanced learner’s dictionary defines tax as sum
of money to be paid by citizens (according to income, value of purchase etc.) to the government
for public purposes Tax as a compulsory contribution whether direct or indirect, levied by a
public authority on the inhabitant of a country. There are various classes of tax but all of them are
usually classified as direct and indirect taxes.

This classification is usually based on the incidence of the particular taxes. Direct taxes are more
visible to the tax payers and they include such taxes as income tax, estate duty and property tax
levied on the person (whether individual or non-individual) with no responsibility of shifting the
incidence to a particular person. Indirect taxes are generally taxes on consumption and outlay.
They are often less visible to the tax payer and collected by an intermediary. (Yaru, 1999).

It has long been evident that business income tax in Ethiopia has remained the most
unsatisfactory, disappointing and problematic of all the taxes in the tax system today. This is in
spite of the fact that the reform has of resent been a key element in economic reform which the
felt that business income taxation in Ethiopia requires radical handling to ensure that tax officials
are adequately trained Business income tax is closely related to the pace of development and
growth of the economy. An effective tax system ought to satisfy the twin purpose of raising
maximum revenue and at the same time encourage economic growth and development. An
effective tax system, aside from maximizing revenue for development, ought to, if well-

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structured and managed to elicit the feeling of common purpose, joint responsibility of obligation
amongst the tax officials in a country. (Harvey .S.R. 2008)

Business Income tax is charged on all the income of an entity having a permanent establishment
in Ethiopia. An administrative branch, branch, factory, workshop, mine, quarry or any other
place for exploitation of natural resources, and a building site or place where construction and/or
assembly works are carried out is considered to be a permanent establishment. Income tax
applies to residents of Ethiopia with respect to their worldwide income, and non-residents of
Ethiopia with respect to their Ethiopian-sourced income. Revenues from the business Income
Tax collections are an important source of income for the government of Ethiopia. (Thomas M.
2010).

1.2. Statement of the Problem

The main source of financing government expenditure is tax. In recent year almost all
government in the world are founding their needs towards such items that payments for defense
and social security’s construction of infrastructure facilities, provision for food shelter and
medical care and other through collections of tax. It is in evitable that a government could not
run long without having sufficient amount of income. This may motivate many governments to
look for means of revenue generation. It is also clear that direct tax is one of the main
components of a country’s revenue which contributes a significant amount to the country’s total
revenue. To a chive the accomplishment of the government’s requirements and objective a well-
developed tax policy formation, methods of Colleton implementation of rules and regulations
trained human resources to assess and effect collection of tax are required. (Hussein 2003).

Business income tax collection no doubt poses lots of challenges in the tax system, the Ethiopia
situation in general and those bacho woreda in particular, seems unique when viewed against the
scale of corrupt practices prevalent in country. Under direct taxation as practiced in Ethiopia, the
major problem lies in the collection of the taxes especially from the self employed such as the
businessmen, contractors, doctors, accountant, architects and traders in shop among others in
bacho woreda. A civil servant and other salaried workers are the only class of people that
actually pay tax in Ethiopia. Similarly, despite the provision meant to plug loopholes through
which taxable persons can minimize tax liability, the self-employed persons employ all kind of

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schemes to escape tax liability and make one wonder whether there are still any tax official
working in that capacity

In bacho woreda social services like: roads, transport, electricity, telephone and health services
are very limited. To alleviate these problems the existence of effective and efficient tax
assessment and collection is more important but in the woreda there is a weak tax administration
and poor tax assessment and collection system which lends to low tax revenues. (Demirew
Getachew, 2007).

1.3 Research Question

The researcher is aimed at providing answers to the following research questions:

1. Is the collection of business income tax in bacho woreda tulubolo town applicable?

2. What are the possible causes of ineffective tax system in bacho woreda tulubolo town?

3. What are the possible ways of ensuring an effective tax system in the bacho woreda
tulubolo town?

1.4 Objective of the study

1.4.1 General Objective

The objective of the study will be the effectiveness of business income tax collection in bacho
woreda tulubolo town.

1.4.2 Specific Objective

In specific terms the study is designed to:

1 To determine the applicable of business income tax collection in bacho woreda tulubolo town.

2 To identify the possible causes of ineffective tax collection system.

3 To identify ways of ensuring an effective tax system in the Tulu bolo town.

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1.5 Significance of the Study

The research will be benefit to students, researchers, government, and the tax officials in bacho
woreda tulubolo town in the following ways: This study will be help to fill loopholes as regards
the literature on business income tax, hence, aiding the bases for further research in this area. The
research will also broader knowledge of students in the area of business income tax. Government
on its part can use the study in the formation of policies so as to ensure an effective tax system,
tax officials in particular will gain better insight on how efficient they should go on with their
assignment so as to bring sanity and gain public trust

1.6 Scope of the Study

For convenience purpose, the bacho woreda tulubolo town Board of Internal Revenue Service
located in Area of bacho woreda tulubolo town is to be used for this study. This is because tax
officials is hoped to be assessed together here, and moreover it is the researcher’s place of
residence. The study is premised at studying the effectiveness of business income tax collection
by obtaining responses from revenue official of State Board of Internal Revenue. Thus, the study
will restricted to also identifying the possible causes of ineffective tax system and the possible
ways of ensuring an effective tax system in the woreda. The researcher can effectively lay hand
on materials relating to these periods

1.7 Limitations of the study

While conducting the study the researcher has faced several limitations throughout the whole
process. Some of them include in accessibility of secondary source /related literature review/ for
documentary analysis and primary sources specially respondents lack of interest to give accurate
and reliable information expected from them. Some of them are not volunteer to tell-accurately
what they have been asked. Moreover, financial constraints will be one of the other great
problems that the researcher has faced and lack of personal experience that back /aid/ him in
doing such research studies is some of the constraint the researcher has faced.

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1.8 Organization of the study

The Study is organized into five chapters. The first chapter introduces the background of the
study, the research objectives and questions, significance of the study, scope of the study, and
organization of the study. The second chapter presents review of the related literatures. The third
chapter deals with methodology of the study. The fourth chapter describes the analysis, results
and discussions. The fifth chapter presents the conclusion and recommendations drawn from
findings of the data in addition with implications for further research.

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 Chapter Two
2. Literature Review
2.1 Definition of Tax

A tax is a compulsory payment and those who are taxed have to pay the sums irrespective of any
corresponding return of services or goods by the governments. In other words a tax payer does
not receive a definite or direct benefit from the government. Here the word directs indicates it is
not paid by tax payer for any definite service rendered or a commodity supplied by the
government. This means the tax payers do get money benefits from the public expenditure true
may go to any one irrespective of tax paid Further more tax is a liability imposed up on the tax
payers who may be individual group or other legal entities on account of the fact that the tax
payer have income of a minimum from certain specified or that they own certain tangible or in-
tangible property or that they carry on a certain economic activates which have been chosen for
taxation (sorues H.L Bahitia 1996, P 33).

2.2 Importance and objective of taxation

Taxes levied by federal state and local governments are significant part of a cost operating
typical house held as well as business enterprises every manager who makes a business decision
and every individual who makes personal investment urgently need some knowledge of income
taxes (solce, Robert F. meiges P. 833)

The purpose of income tax include several goals apart from raising revenue, which are
influencing the rate of economic growth encouraging full employment combating inflation
favoring small business and redistributing national income on a more equal basis (Ibid P. 832).

Even if the prime objective of taxation is to raise revenue, taxes are used for other purposes. To
change the distribution of income, to make the recipients of certain benefits part the cost of
generating those benefits, to minimize the cost of running the tax system and enforcing the
collection of tax and to change people behavior for example to discourage smoking by making to
more expensive (w.zHirch, 1990,p89)

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2.3 Classification of tax.

The distraction between direct and indirect tax is not always as satisfactory consistent one. There
has been a long tradition in economic literature to classify taxes in to chose categories one way
of distinguishing between those two hose been in terms of incidence of taxation. It is asserted
that if the evidence of tax resets up on the person who bears its impact then it is direct tax. In the
other hand if the incidence is posed on to others then it is an indirect tax, (H. Bahitia 1994 p140-
141)

2.4 Tax Bases for Business income

Business income is measured by subtracting all business cost from business receipts over a
period of the year. To calculate business income we would first add up the receipt the business
takes in from sales of its products and services. Then we will add net capital gain on all business
assess held during the year to the business income. After gross income will be calculated, we will
deduct the cost of operating the business during the year. Those costs include it labor cost,
interest cost payment, payment for materials and services purchased from other firms and a
major of cost of capital equipment used during the year. After deducting all business costs we
will have a measure of the profit of the business its net taxable income. In the case of sole
proprietor ship operated by its owner part of the cost of operation is the opportunity cost of the
owner operator’s labor, because the labor the owner is not hired in the market place, nether
payment for labor services nor deduction for that, labor cost is ever recorded on business books.
However the owner operator’s labor is part of the opportunity cost of running the business and it
should be deducted from the gross income (DavidllHymiin 1996, p.491)

From the above statement we understand that tax base is the item or economic activities on
which tax levied. The most commonly used tax base can be groped in the three broad categories
income, consumption, and wealth .As proclamation number 286/2002 Art 18, taxable business
income shall be determined per tax period on the basis of the profit and loss or income statement,
which shall be drawn in compliance with GAAP, subject to the provisions of this proclamation
when the directives issued by the tax authority.

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2.5 Tax Rate

Tax is the amount per unit to be taxed. To determine the tax liability the tax rate is multiplied by
the base according to the tax schedule, (luz. Hirsch 1990.p.90).In Ethiopia, bodies (company,
registered partnership entity formed under foreign low rambling a company or registered
partnership or any public enterprise) are taxed at the rate 30% and the other tax payers shall be
taxed at the rate with respect to their annual taxable income in accordance with schedule “C”
according to proclamation number 286/2002, Art 19.

2.6 Tax Assessment

Assessment is a tax review a tax official of the tax declaration and information provided by a tax
payer and a verification of the arithmetical and financial accuracy of the declared tax liability.
The definition of the amount subject to taxation under a particular structure requires an analysis
of the tax payers situation and of legal provision that apply to him with the income tax (and also
some taxes on the transfer of property, such as in heritance tax) the tax payer submits a tax return
providing information as the his occupation his real and personal property, his professional
expenditure and other pertinent matters. (Robert F.Mugs .832). Pursuant to proclamation number
286/2002 the procedure for assessing of business income tax taxes two forms:

A. Assessment by books of account

B. Assessment by estimation
Assessment by book will be done for those who maintains book of account (category A&B) the
revenue authority makes assessment by estimation when the tax payers do not maintain the
books or when the submitted books are not acceptable and when the tax payers fails to declare
his/its income within the time prescribed by this proclamation.
2.7 Classes of income tax payers

Income tax recognizes four classes of tax payers. Individuals, corporations, estates and trusts, A
business organized as a sole properties ship or partnership is not taxed as a separate entity
whether or not the income is withdrawn from the businesses.

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However to partner-ship must sill on in-formation return showing the computation of total
partnership net income and the allocation of this income among the partners.

A corporation is separate taxable entities it must file cooperate income tax return and pay a tax
on its annual taxable income.

In addition individual stock holders must report dividends relived from corporations as part of
their taxable income. The taxation of corporate dividends lead to the charge that there is double
taxation of a corporate income one to the corporation and again when it is distributed to stock
holders (Meigs P.7777-7778)

Pursuant to proclamation number 287/2002 schedule “C” tax payers are categorize in to category
“A” “B” “C” bossed on their annual turnover accordingly

1. Category “A” shall include

A. any company incorporated under the laws of Ethiopia or in foreign county
B. Any other business having an annual turnover of birr 500,000 more
2. Category “B” unless already classified in category “A” any business having an annual
turnover of over 100,000 birr
3. Category “C” unless already classified in category A&B whose annual turnover is
estimated by tax authority as big up to birr 100,000

2.8 Tax Administration

Tax administration pay a significant role in over all government activates. Tax laws and
regulations must be comprehensible to the tax payer they must be as simple as possible, given
other goals, as well as the ambiguous on certain, both to the tax payee and to the tax
administration. (Norman .D nowark )

There are four general requirements for the efficient administration of tax laws:-clarity,
continuity, cost effectiveness and convenience (encyclopedia Britain )

2.9 Problem of Business income tax Collection

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The assessment and collection of business income tax from taxable individuals have been
difficult in the country. These problems as though peculiar to different countries, in Ethiopia,
the problems include:

2.9.1 High rate of Tax Evasion.

A greater part of business income tax yield is from employee whose income taxes are deducted at
source from their salaries and wages. Due to the inadequate monitoring machinery, the self-
employed and professional in private practices hardly pay tax. These categories of tax payers
seem to be worst culprits in terms of tax evasion- a criminal offence. It is necessary to bring
more of those self-employed taxable adults into the tax net.

2.9.2 Several Unmodified Amendments

The rules and regulations governing business income tax in Ethiopia today amendment which
istle latest, there had been several amendments issued from time to time. Due to these frequent
amendments, the certainty of tax rate and accessibility to legislative instrument become very
difficult and confession, even to the tax administration themselves. The tax rates, reliefs,
allowances and allowable expenses become unclear to the tax payers. This is part of the reasons
why voluntary compliance habit is very low among Ethiopian tax payer. The hallmark of a
good tax administration is to access tax payer’s honesty and to issue out genuine tax clearance
certificates. This is not the case at the moment in Ethiopia.

2.9.3 Skills among the State Internal Revenue Officials:

This is another area of failure of tax administration in Ethiopia. The board inspectors are not
knowledgeable enough both in reading the accounts of the payee and in keeping the internal
accounting record of their assessment and collections.

2.9.4 Corruption on the part of some tax officials:

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The tax officials cannot be excused for their high level of corruption; it is a major problem these
days that a lot of collections meant for governments purpose, end up in individuals ‘pockets. This
has contributed to low compliance attitude among potential tax payers. Ethiopians always
complain that much of the taxes collected will be either mismanaged or pocketed by corrupt tax
officials.

2.9.5 Quality and quantity of personnel:

With regards to the staffing problem, oluwakayade and aregundade (2011) observed that a
major shortage of tax personnel in terms of both the quantity and quality contributed in no small
way to lower tax yield being reported by relevant tax authorities. The board (both federal and
state) are often under staffed while most of the available staff are not adequately trained, huge
tax are therefore left uncollected for collection purposes. Such tasks as tax-auditing, enumeration
of
tax payers, compilation of databases of tax payers that are essential for maximum tax yields areth
erefore left untouched.

2.9.6 Poor provision of logistics

Enough working materials are not made available to the administrators. Vehicles are not made
available for tax devices and the few available ones are used for personal errands of big bosses at
the expense of official assignment. Communication facilities like telephone, mobile phones,
raid equipment, or even ordinary intercoms that can facilities easy contact between tax officers
and tax and their colleagues are not provided. Enough funds aren’t provided for tax officials,
resulting into situation where necessary materials like stationery, office equipment, printing of
forms and tax leaflets, etc could not be procured. The result is poor tax yields.

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 2.9.7 Community Development/ Government Expenditure:

In some communities where social amenities like; water, electricity , roads and health facilities
are in irregular supply or are non-existence at all, tax payers could not see what
benefit payment of taxes would bring to their community. Tax administrators also find it difficult
to explain to such tax payers why they should continue to pay tax. This type of situation as
pointed out by Abdulrazaq (2002) is the bedrock of high level of tax evasion that is prevalent in
the country. To reduce this problem, government expenditure must be perceived by tax payers
as being geared towards community development projects that yields can identify with.

2.9.8 Lack of Cooperation from Government Agencies/ Department

Almost all other government department will have one thing or the other to do with tax boards.
Unfortunately, there is no coordination of activities of these departments that could have
assisted the board to build up-to-date data base. Each department keeps to its chest information
that is available to it and these are not passed over to the Boards. It is therefore very difficult to
have a complete Audit trial of a taxable event.

2.9.9 Absence of tax information for Tax payers

Most of the payers are ignorant about existing tax laws and their application in their tax affairs.
The population has not been sufficient educated and enlightened on the provisions of various tax
laws. There is absence of information in the public domain on some relevant tax matters.
For instance, majority of the people do not seem to understand the legal implication of not
having their documents stamped in accordance with the stamp duty Act. In some instance, even
upon engineering, relevant tax authorities are very reluctant to disclose pertinent information to
tax payers. The taxpayers need to be educated about their statutory obligations.

2.9.10 Lack of Enforcement Powers

The tax administrators have no power to arrest and detain tax defaulters. Even the threats to
sanctions on defaulting, negligent or fraudulent tax payers cannot be effectively carried out. The
tax administrators are not empower will bed to carry out the enforcement procedures as provided
in the Act. Erikson (2003) noted that the absence of the tax administrations to enforce tax
payment has brought ineffective enforcement arrangement and has reduced Ethiopia Tax
Administrators to toothless bulldogs.
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 Chapter Three
Research Methodology
3.1 Research Design
The design of the study is a descriptive survey as one in which a group of people or items is
studied by collecting and analyzing data from only few people or items(sample) considered to be
a fear presentation of the entire group, and the finding from the sample expected to be
generalized to the entire population. So, this study will be employ descriptive survey research
method because it will be believed that it help to describe the assessing effectiveness of business
income tax collection in bacho woreda tulubolo town. This method is relevant in expressing what
is happening currently and finding detailed information’s. In the study, the researcher will be
used both qualitative and quantitative approach.

3.2. Sources and Method of data collection

Both primary and secondary data will be collected from the respondents. The primary data will be
gathered through questionnaire and interview from employees of bacho woreda tulubolo town
internal revenue bureau; whereas the secondary data will be collect from reports, bulletin
document and policy document.

3.3. Population and Sampling technique

From the total population of 38 employees of bacho woreda tulubolo town internal revenue
bureau 22 of this employee will be selected as a sample size by using judgmental sampling
techniques. Because of this 22 employees are a specially engaged in the area of business income
tax collection. These 22 employees are more reliable information about effectiveness of business
income tax collection in the woreda.
3.4 Method of Data Analysis and Presentation the Outcome
After all relevant and authentic data will be collected, the next logical step will be data analysis.
The most predominant analytical tools will be used percentage analysis. Then, the data analyze
demand suitable and best fitting presentation methods. The method geared to presenting data will
be used for both quantified and qualitative results of analysis. The latter will be presented as in
the way of analysis that is critical explanation. The outcome of analysis under the heading of
quantifiable will be presented with making of tables.

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